Here is another good piece from Ruff NSS thread;
Desking and Continuous Net Settlement (CNS) may be factors in any company's current NSS stock situation...
1. What is Desking? A broker-dealer takes a client's order, prints the trade (so you see it go through) and lists the shares in a client's account, but they don't bother buying anything. Effectively, the brokerage has naked shorted it's client. Desking trade accounts are maintained in proprietary books (C and D level) and contents may be traded/exchanged with other broker-dealers privately, being settled via External Clearing (outside the Continuous Net Settlement process).
A. A brokerage can own less shares than their clients own in aggregate.
B. Clearing brokerages can own less shares than the aggregate of the introducing brokerages.
C. Foreign depositories can own less than the clearing houses and brokerages that have accounts with them.
D. The DTCC can let brokerages and clearing houses have negative account balances (outstanding delivery obligation).
2. How does it transpire?
A. Buyers and sellers at an introducing brokerage are netted and applied to the existing long position.
Example 1: Desking
You want to buy 1,000 shares, but no one wants to sell and the broker-dealer has 10,000 shares in inventory all belonging to real customers. They "desk" the trade to you. One of their own customers effectively now has 1,000 phantom shares in their account. Customers think they own 11,000 shares collectively, but the house only owns 10,000 shares. Then the process repeats and the phantom share count grows.
Example 2: Continuous Net Settlement
Someone at the broker-dealer sells short 10,000 counterfeit shares, but other buyers at the house buy an aggregate of 10,000 shares. The counterfeit sale is masked by the real long buys.
10,000 in inventory + 10,000 real purchases - 10,000 counterfeit sales = 10,000 in inventory.
No change is required to the house's reported inventory position (the house doesn't owe anyone anything) and the 10,000 sales are completely masked. Their clients own 10,000 real shares and 10,000 phantom shares.
Example 3: Mismarked Trades
Someone at the broker-dealer sells short 10,000 counterfeit shares in a high volume stock, "erroneously" marks them as "long" trades for clearing, then sells 10,000 counterfeit shares short marked as "short." The counterfeit sale is masked by the mismarked long buy.
10,000 in inventory + 10,000 mismarked purchases - 10,000 counterfeit sales = 10,000 in inventory.
No change is required to the house's inventory position (the house doesn't owe anyone anything) and the 20,000 sales are completely masked. Their clients own 10,000 real shares and 20,000 phantom shares. Only a detailed audit will reveal the mismarked trade.
B. Introducing broker-dealers clear through clearing brokerages. The clearing houses treat the brokerages like customers and the exact same scam can happen at this level.
The bad brokerage effectively borrows long positions from the good brokerages that all hold their assets at the clearing brokerage. All the long and short positions at the various brokerages are netted at the level of the clearing house. Counterfeit trades can be masked at this level and the clearing house may have no outside obligation.
C. The Clearing Brokerage may net at a foreign depository. They can borrow from any other member in the depository. Note how the system is starting to get clogged up with phantom shares and we aren't even at the DTCC yet.
D. The foreign depository is a participant at the DTC and they net their trades with the CNS system. Because of the hassle of cross border transfers, they will avoid actually transferring any shares into or out of America, in most cases handling short falls from the stock borrow program. That means that huge trading in Canada or Germany could have a minimal short term impact on share prices as everything is dampened by stock loans and phantom shares.
E. If the stock borrow program can't cover up trading short falls, then they show up as "fails to deliver". SHO doesn't disclose these unless they exceed a threshold at one clearing account. Many Clearing Brokerages have multiple clearing accounts and can spread the fail over various accounts to stay below the threshold.
3. How can a short be determined? For the individual company the only way to know if a NSS disparity exists is to take the Shareholder list from the TA and look for the total number of shares that are held by CEDE (A division of Depository Trust Corp. (DTC) that is the "vault" division that is supposed to hold the "certs" for around 90% of "street name" positions) and other much smaller equivalents of CEDE like Canadep (stock held from Canadian brokerage firms) and Midwest who hold pretty much the balance.
The TA's Shareholder List is supposed to always total the number of shares issued and outstanding. It is made up of individual names and addresses of all shareholders who hold certificates in their own name, both unrestricted and restricted, and for brokerage held "street name" stock, the certs show up under the CEDE and the other two. The TA Shareholders List is easily obtained by any company from its Transfer Agent.
After the Company gets a current TA Shareholders list, they then need to get a copy of the Security Position Reports "SPR's" from the DTC. This is a list of all brokerage firms that hold stock in "Street Name." The SPR's do not give the breakdown of shareholders, just the total amount held by each Brokerage firm including both NOBO and OBO.
If the total of shares held in "street name" (SPR NOBO/OBO) exceeds the number of shares that show up on the TA Shareholders list under the three "Depository's" mentioned above, the difference should be what is short. If a stock is very active, there could be some lag time in clearing that might give the appearance of a short at a moment in time. But once the volume slows down for a period of time, and you still have the discrepancy you will pretty much know the short position.
A company could have a problem getting the SPR from the DTC. DTC has been a legal target of many as being part of the problem that has created the naked shorting issue. Their lists are proprietary to them and they are not required to give the SPR list to any company. But it is a subscriber service that they make good money from. They charge companies $87 each time a subscriber downloads their list. The list is always at least three days old due to the settlement process.
I hope that helps all understand the complexity of issues.
(Data incorporated from various sources and posters.) |
